The value relevance of “too-big-to-fail” guarantees

Armin Varmaz (School of International Business, University of Applied Sciences Bremen Bremen, Germany)
Christian Fieberg (Chair of Finance, University of Bremen, Bremen, Germany)
Jörg Prokop (Department of Business Administration, Economics, and Law; Area Finance and Banking, University of Oldenburg, Bremen, Germany)

Journal of Risk Finance

ISSN: 1526-5943

Publication date: 16 November 2015

Abstract

Purpose

This paper aims to analyze the impact of conjectural “too-big-to-fail” (TBTF) guarantees on big and small US financial institutions’ stock prices during the 2008-2009 banking crisis.

Design/methodology/approach

The paper analyzes shocks to stock market investors’ expectations of government aid to banks in distress and respective spillover effects using an event study approach. We focus on three major events in late 2008, namely, the Lehman bankruptcy, the Citigroup bailout and the first announcement of the Capital Purchase Program (CPP) by the US Government.

Findings

The authors found significant differences in market reactions to the respective events between small and large banks. For both the Lehman and the CPP event, abnormal returns on big banks’ stocks are negative, while small banks’ stocks tend to generate positive abnormal returns. In contrast, large banks strongly outperform small banks in the case of the Citigroup bailout. Results for a control group of non-financial firms indicate that this behavior may be specific to the banking industry. The authors observed significant spillover effects to both competitors and non-competitors of Lehman and Citigroup, and concluded that while the Lehman event shook the widely held belief in an implicit TBTF subsidy to large banks, the TBTF doctrine was reinstated shortly thereafter.

Originality/value

This paper shows that conjectural TBTF guarantees are priced in by equity investors. While government aid to large banks in distress may prevent negative effects on the stability of the financial system, it may also create negative externalities by putting small banks at a competitive disadvantage. The findings suggest that US and European regulators’ recent policy measures directed at establishing reliable bank resolution schemes should be a step in the right direction to level the playing field for small and large financial institutions.

Keywords

Citation

Varmaz, A., Fieberg, C. and Prokop, J. (2015), "The value relevance of “too-big-to-fail” guarantees", Journal of Risk Finance, Vol. 16 No. 5, pp. 498-518. https://doi.org/10.1108/JRF-06-2015-0056

Download as .RIS

Publisher

:

Emerald Group Publishing Limited

Copyright © 2015, Emerald Group Publishing Limited

Please note you might not have access to this content

You may be able to access this content by login via Shibboleth, Open Athens or with your Emerald account.
If you would like to contact us about accessing this content, click the button and fill out the form.
To rent this content from Deepdyve, please click the button.